Download Market Disturbances

Markets2 Manual
Purpose of the Program
This program allows you to manipulate a perfectly competitive market in a number of ways. In
the process you can observe some of the ways this type of market reacts to assorted disturbances.
The program allows you to change the strength of the influence of each variable on the market. It
also allows you to interfere with the market, as governments often do, and to observe the
consequences of your interference. This should allow you to draw some conclusions about the
usefulness of such interventions.
The Basic Model
The market you are about to disturb is the market for new houses which comes close to the
economist's definition of a "perfectly competitive market." (No real world markets exactly
match that definition.) Below is a comparison of the requirements of "perfect competition" and
the facts about the market for new houses.
Perfect Competition versus
An infinite number of sellers (firms
or individuals) versus
An infinite number of buyers versus
Perfect free information about
prices versus
Every seller produces exactly the
same product and all potential
buyers know that the products are
identical versus
Free entry into the industry (no
special start up costs), and free exit,
no special costs for leaving the
industry versus
New Housing Market
Thousands of firms in the U.S.
Millions of buyers.
Information is cheap and easy to get.
There are many varieties of houses, as well as many
locations (which makes a difference) but it doesn’t
matter much which firm built a house.
There are entry and exit costs, but they are not very
large.
Firms borrow large amounts to start a
development, but the security is mostly the land and
equipment, so at least in good times it isn’t too hard or
expensive to borrow.
Supply
Suppliers—those prepared (if conditions are right) to sell a given product in this market—are
assumed to be business firms. The suppliers, home builders in this module, are assumed to be
motivated by only one thing: profit. Ignoring all sorts of potential complexities, profit is defined
as the total revenues of the firm minus the total costs of the firm. The number of homes that any
firm is willing to build and sell depends on two things: the price of the product and the firm’s
costs. In a perfectly competitive model the firm considers the price of the product to be a fixed
value -- totally out of its control. The firm’s costs depend on how much it produces and on
technology, resource prices, laws, and other things as well.
In the short term firms cannot change some of the resources they use in production—they can
neither increase nor decrease the amount used. Example: the size of the building they have as a
production facility. In the case of home builders some construction equipment would fall into
this category. As a result of having some fixed resources they are subject to the Law of
Diminishing Marginal Returns. If they try to increase production, they add more and more of
the resources they can control to the fixed amounts of the ones they cannot control. The result is
that increasing production increases the cost of producing additional units. This can be seen
from the following example:
Current production = 100: Adding 1 more unit takes 10 more hours of labor, each hour costs $10,
the added unit costs $100
Current production = 101: Adding 1 more unit takes 11 more hours of labor, each hour costs $10,
the added unit costs $110
Current production = 102: Adding 1 more unit takes 12 more hours of labor, each hour costs $10,
the added unit costs $120
Holding constant all other things that might affect costs and production, the result is a Supply
Curve as in Figure 1. A firm’s supply curve is the line showing the quantity it is willing to
produce and sell at each possible price. The larger the quantity produced, the higher the unit cost
of the extra unit and the higher the price required to cover that cost. No firm is willing to supply
a unit of the product that costs $120 to produce if the price it expects to sell the unit for is less
than $120. On the supply curve therefore the Law of Supply shows the higher the price, the
larger the quantity the firm is willing to produce. That is why the supply curve slopes upward.
See Figure 1 The Supply Curve
Influences other than the price of the product can change the quantity supplied at a given price.
If something makes it cost less to add units to production, then the supply curve moves away
from the vertical axis. (This is referred to as an “increase in supply”.) If something makes it
more costly to add to production, the supply curve moves toward the vertical axis. (This is
referred to as a “decrease in supply”.) (See Figure 2.)
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This describes supply by a single firm. The behavior of the (“infinite”) number of firms in the
market is just like supply by a single firm, only the quantities are larger.
See Figure 2 The Supply Curve
The quantity of houses supplied at all possible prices is described by the supply curve. It can be
shown either as an equation or a graph. In this module the original equation for supply of houses
is (where GBS is the subsidy a construction firm could get for building a house):
Qs = 1*(-1000 + 70*(GBS) + 50*(House Price *(1–Tax))) * (# Firms / Lumber Cost)
All numerical values in this equation (including the 1 just after the = sign) are “parameters”
which you will be able to change while running the module. Qs is the quantity of houses
supplied. It is positively affected by the price of a house, net of a tax on sellers set as a percent
of the selling price. It is positively related to the Government Building Subsidy, positively
related to the price of homes, negatively related to lumber cost, and positively related to the
number of firms. If GBS is $10 (per square foot), lumber cost is $10 per board foot, the tax rate
is zero (no tax) and the number of f1rms is 1,000, then the supply curve looks like Figure 3.
(The price of $17.33 and the quantity of 566.5, define one point on the supply curve. Note that
the price of a home can be read either as the price per square foot of a house of average quality
or as the price in thousands of dollars of an average size house.)
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See Figure 3 The Supply of Houses
566.5
Demand
Every individual in the market has to decide how much to buy of this product, and even whether
to buy it. At a given price for this product, the decision for a single person (or family) is going to
be based on three basic things: (1) the opportunity cost of buying the product; (2) the real income
of the person; and (3) the preferences (tastes) of the person.
The opportunity cost involves three types of prices: The price of the product itself, the prices of
goods that are substitutes for this product, and the prices of goods that are complements to this
product. Suppose the product is ice cream and its price is $2 per gallon. A substitute for ice
cream is frozen yogurt, suppose its price is $1.50 per gallon. Ignoring complements for the
moment, the opportunity cost of buying a gallon of ice cream is that the $2 spent on that is $2
less that can be spent on frozen yogurt. The “opportunity cost” of the gallon of ice cream is 1.33
gallons of yogurt that you now cannot buy. If the price of yogurt were $2 the opportunity cost of
buying ice cream drops to 1 gallon of yogurt. That encourages people to buy more ice cream.
A complement to ice cream is chocolate syrup. Suppose the “typical” buyer in the market likes a
pint of chocolate syrup with an average gallon of ice cream, and the price of syrup is $1 a pint.
The decision to buy the ice cream is conjoined with the decision to buy the syrup. Now the
overall cost is really going to be $3, and the opportunity cost (if syrup and ice cream are not
consumed together) of buying the ice cream is now—at a yogurt price of $1.50—two gallons of
yogurt. If the price of syrup went to $2 a pint, the opportunity cost of ice cream/syrup would go
to 2.66 gallons of yogurt ($4 for the combo, versus $1.50 for the yogurt). This would discourage
the purchase of ice cream.
How much ice cream a person buys depends on how much real income the person has. If your
income is such that at an ice cream price of $2 a gallon you would spend all your income for a
week buying one gallon—you are not going to be buying two gallons a week. That’s true even if
the ice cream was all there was in the world that you ever wanted. Overall, the lower your real
income, the less you’ll buy. There are exceptions, but ice cream isn’t one. (Houses aren’t either.)
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If the price of ice cream goes up, the opportunity cost of ice cream goes up, the buyer’s real
income goes down and for both reasons the amount of ice cream bought will go down. The Law
of Demand: the amount bought moves in exactly the opposite direction from the way price
moves – if price goes up, the amount bought goes down, if the price goes down, the amount
bought increases. Holding constant all other things that might affect the consumer’s behavior,
the result is a Demand Curve as in Figure 4.
See Figure 4 The Demand Curve
Changes in the prices of other goods or in real income can increase or reduce demand. Those
kinds of shifts in demand are illustrated in Figure 5. For example, assume homes are a superior
or normal good, if real income increases the demand will increase, or shift to the right. If real
income decreases, the demand will decrease, or shift to the left.
See Figure 5 Shifts in the Demand Curve
The number of homes bought at all possible prices is described by the demand curve. The
demand curve can be shown as an equation or a graph. For the new housing market, the demand
equation is:
Qd =833.48 –10*(House Price*(1+Tax))+30*(House Rent) – 20*(Furniture Price)+10* (Income)
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Where Qd is the number of houses bought. Qd is negatively affected by the price of houses (the
higher the price—tax included, the fewer are bought), it is positively related to the cost of renting
a house or apartment, negatively related to the price of furniture, and positively related to the
income of consumers (measured in trillions of dollars).
If the tax rate is zero, the rent on housing is $10, the price of furniture is $4, and consumer
income is $5 trillion dollars, then the demand looks like Figure 6. (The price of $50 and the
quantity of 603.5 (to one decimal point) define one point on the demand curve.)
See Figure 6 The Demand for Houses
Market Equilibrium
In this kind of market, the movements in price and amounts bought and sold are explained by the
interactions of buyers and sellers in the market. Equilibrium in the market is a combination of
price and quantity at which no one (buyer or seller) has any reason to change decisions. This is
the point where the demand and supply curves cross (in Figure 7, the equilibrium price is Pe and
the equilibrium quantity is Qe).
See Figure 7 Market Equilibrium
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A change in demand or supply changes where the equilibrium is, since either way there has been
a change in behavior -- either by buyers (demand), or by sellers (supply).
Figure 8 shows the results of a rise in demand. For some reason (e.g., a rise in income) the
amount demanded at the original equilibrium has increased. At the original equilibrium, the
amount people want to buy is larger than the amount firms are willing to sell. Buyers offer
higher prices to get what they want, sellers are willing to sell more if they get the higher price.
Eventually price reaches a new (higher) equilibrium value (Pe’, Figure 8) and quantity reaches a
new (higher) equilibrium value (Qe’, Figure 8).
See Figure 8 Changes in Market Equilibrium
Putting supply and demand together for the housing market gives the picture below.
Equilibrium, given the values of other prices, taxes, income, input costs, the number of firms,
and the government subsidy, is at the intersection of the two lines.
See Figure 9 Equilibrium in the House Market
23.39
869.57
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Consumer and Producer Surplus
A consumer who would have been willing to pay $100 for a home, but who actually winds up
paying the equilibrium price of $23.39 gets a “surplus,” the home is worth $76.61 more to the
consumer than what he/she has to pay for it. This is true in figure 9 for all consumers who
actually buy homes except for the one who bought the last one—paying $23.39 for a home that is
just worth $23.39 to the consumer. The total amount of the surplus received by consumers at the
equilibrium in figure 9 can be seen as the area of the red triangle in figure 9a.
At the same time, there were producers who were willing to supply some houses at prices lower
than $23.39 (e.g., one at $6), but who wound up selling them at $23.39. They are being paid
more than the price that had to be paid to give them the incentive to produce houses, for this one
$17.39 more. The amount over the minimum price needed to get a house supplied is the
producers’ surplus. The total producers’ surplus is different from the total profit made by firms
since the calculation of profit involves costs that are not taken into account when figuring
producers surplus. One way of expressing this is that an extra dollar of producers’ surplus is the
same as the marginal contribution to profit from producing that unit. However, if for example,
firms have fixed costs a firm could be getting a positive total producer’s surplus while getting a
total profit value of zero or even a negative number. The area of the blue triangle in figure 9a is
the amount of producers’ surplus received by firms at the equilibrium price and quantity.
See Figure 9a
Market Disturbances
This program uses a market that is as close to perfect competition as can be found in reality.
Starting with an initial equilibrium, the program allows you to change the market in a number of
different ways. You can change the parameters of both the supply and demand curves – the
sensitivities of quantity demanded or supplied to changes in the variables that affect the results.
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With a given set of parameter values you can shift demand (up or down) by altering the price of
a substitute or a complement, or by changing real income. You can change supply by altering
the government building subsidy, lumber cost, or the number of firms. Such changes will cause
(at the same price) more or fewer new houses to come to the market. Doing any of these things
changes the equilibrium price and quantity. Part of your job is to understand why a particular
change caused a move to a particular equilibrium. In the process work out why the total amount
spent in each case increases or decreases. (Hint: use the concepts of “price elasticity of demand”
and “price elasticity of supply” in figuring this out.) Another result of any change you make will
be that the amounts of consumer and producer surplus will change, and not generally to the same
degree. You should be prepared to figure out the “why” of these changes as well. (Hint: The
relative sizes of consumer and producer surpluses will depend on the slopes and positions of the
demand and supply lines.)
Demand Variables
“Demand” means the amounts of a good people in the market are willing and able to buy, depending
on the price of the good, prices of other goods, their income, and other variables not used in this
module. You can “disturb the market”, that is, change one of these Demand Variables and observe the
results. Changing one of the Demand Variables will “shift” the demand curve and produce a new
market equilibrium. All these variables can be changed—one demand variable at a time.
Demand Parameters
The demand parameters are the coefficients in the equation on page 5 – the intercept term
(833.48), the slope (-10), the impact of the rental price (30), of the price of furniture (-20), and of
income (10). At these values an increase of $1 in the price of house reduces the quantity of
house bought by 10, but if you change that parameter you change the effect of a price change on
the quantity demanded. Similarly, if the price of rental price rose $1 people would buy 30 more
bushels of house, but if you change the parameter you change the impact of rental price prices on
house purchases. All these parameters can be changed (one demand parameter at a time).
Supply Variables
“Supply” means the amounts of a good people in the market are willing and able to sell
depending on the price for the good, costs of production, the weather (given the nature of this
market), and the number of sellers in the market. You can “disturb the market”, that is change
one of these “Supply Variables” and observe the results. Changing one of the “Supply
Variables” will “shift” the supply curve and produce the new market equilibrium.
Supply Parameters
The supply parameters are the coefficients in the equation on page 3—the intercept term (-1000),
the coefficient of GBS (70), of the price of housing (the slope, 50) and modifying all these the
remaining coefficient (.1) which can be viewed as a coefficient of the Number of Firms, of the
Cost of lumber, or as a scaling parameter applying to the supply curve overall. In the module it
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is treated as the first two, rather than as the last (all these ways are, or course, mathematically
equivalent).
Market Regulation
After causing demand and/or supply shifts by changing parameters or variables you can interfere
with the market’s “natural” behavior. You have two alternatives: 1) you can regulate the price of
the product, setting a maximum price for houses; or 2) you can set a minimum price for new
houses.
Price Controls
When setting a maximum or minimum price check whether you are causing a surplus (excess
supply), or a shortage (excess demand). Be sure you know which of these has resulted from your
chosen intervention. You should also be concerned with the way price regulation affects buyers
and sellers, how it affects the amount spent on the product, and how it affects the amount
produced and the amount bought. Another concern will be the extent to which your intervention
in the market changes consumer and producer surpluses—and their combined values. (The
combined value—compared to the maximum possible value--is often used by economists as a
measure of the economic efficiency of a market.) You should be aware that some of these items
depend on the elasticities of demand and/or supply.
If you choose to regulate the price, you have certain limitations. The limitations exist to ensure
that your intervention actually has an effect and that you do not destroy the market. If you set a
minimum price, it has to be higher than the price the market would go to by itself (the new
equilibrium price). If you were allowed to set a minimum price lower than that, it wouldn’t
affect the market and you wouldn’t find out what the effects of interfering with the market are.
If you set a maximum price, you are not allowed to set one higher than the market equilibrium.
If you did, the price would never get that high and once again, you would not find out what the
impact of interference is. You also cannot set a minimum price so low there is nothing
produced, nor a maximum price so high nothing will be bought. You have to leave the market
functioning despite your regulation.
Running the Module
When you start running this module the first thing you will see is the “Initial Conditions” screen,
showing the original values of the variables that can shift Demand or Supply. At this point you
can access the help files (through “Instructions” on the tool bar) or continue. When you continue
the next screen shows the original equilibrium—the supply and demand graph and the
equilibrium price and quantity if there is no change in any of the parameters or variables (and no
regulation). At this point you can choose to change a parameter (”Change Parameters”), change
a variable (“Disturb the Market”) or to regulate it (Regulate Market).
If you decide to begin by changing one or two parameters you need to click on Change
Parameters on the tool bar (or use Alt + C on the keyboard). Once you have done this you will
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see a screen offering you the option of changing a demand parameter, or changing a supply
parameter, or changing one parameter for each function. (You cannot change more than one
demand parameter or more than one supply parameter at one time.) You will see an array of
options, one row listing the various demand parameters (or rather the variables they apply to) and
the other listing the various supply parameters (i.e., the variables they apply to).
If you click on one of the demand options a white box will appear containing the original value
of the parameter. To change the parameter, type a new amount in the box. There are limits to
how much you can change each parameter (see the table below), if you exceed the limits set you
will be stopped when you try to go further by clicking on Continue on the tool bar. A message
will indicate your error and you will have to enter a value within the prescribed limits.
Similarly, if you are going to change a supply parameter a white box (a different one) will appear
and you will have to type in your preferred value. As with demand, there are limits to what
changes you can make and you will be stopped at “Continue” if you have exceeded the limits. If
you change your mind as to which parameters you wish to change you can click on “Reset” and
start over.
Range of Permitted Parameter Values
Demand
Intercept
Housing price Rental price
Furniture
price
Range 930 to 775
-7 to -30
1 to 30
-0.05 to -30
Supply
Intercept
Housing price Government
# of firms
Building
Subsidy
Range -700 and -2200
25 to 100
1000 to 350
0.5 to 10
Income
20 to 0.1
Lumber cost
0.5 to 1.5
When you click on “Continue” you will see the “Disturb the Market” screen, the same screen
you would get to if you had clicked on Disturb the Market initially instead of choosing the
change parameters first. At this point you will see a screen with all the supply and demand
variables presented. You need to indicate (by clicking on it) which of these you want to use to
disturb the new home market, and then click on Continue. You can choose either one demand
variable, or one supply variable, or one variable for each. Whichever variable(s) you picked, you
will now see its (or their) original (default) value(s) and should make changes within the
permissible limits. If you choose to make no changes you will see the original equilibrium
(unless you did change a parameter value—in which case there will be a new equilibrium
anyway), if you try to exceed the allowed limits on the particular variable you will be scolded
and will have to pick a new (legal) value.
Demand
Range
Supply
Range
Range of Permitted Disturbance Values
Rental price Furniture price
Income
$1 to $20
$0.10 to $32
$0.1 to $30
Government Number of firms
Lumber cost
Building
Subsidy
3 to 30
500 to 1000
$3 to $40
Tax rate
0 to 10%
Tax rate
0 to 10%
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Once you have successfully disturbed the market you will get to see a new supply and demand
graph, indicating the original equilibrium and the new one (with a different colored supply
and/or demand line—depending on what changes you made). You will also see the numerical
values of the new equilibrium price and quantity. If you now click on “Continue” you will also
see the original and new values for consumers’ and producers’ surpluses. You then have the
choice of going “Back” to the previous screen (graph), starting a new disturbance—in which
case you will be back to the screen showing all the supply and demand variables—starting to
regulate the market. If you want to change a parameter or two, or change the value of a variable
you just used to disturb the market, click on Back, those options are available on the previous
screen.
If you had chosen to regulate the market initially the regulation would have been imposed on a
market which starts at the original equilibrium. If you have changed a parameter or two and/or a
variable or two you will impose a regulation on a market starting at a different equilibrium. If
you choose to regulate the market you go to a screen in which you must choose how to control
the price of this product.
You have a choice of imposing a price ceiling or a price floor. If you choose to impose a price
ceiling, you will (after “Continue”) have to set the price ceiling—a price lower than the current
equilibrium price. If you try to set a price ceiling below the equilibrium you will not be allowed
to do that. Once you have set a proper price ceiling you will get the results of the regulation, the
effects on the price in the illegal market your regulation created, the effect on the amount firms
are willing to produce, on their revenues, and on the profits of criminals. You will also see the
effects of your regulation on consumer and producer surpluses.
If you don’t like the way criminals profited from your policy, at this point you can choose to hire
cops to enforce the price ceiling. If you click on the “Hire Cops” button you will be given the
opportunity to decide on a budget for paying the cops. You will not be allowed to spend more on
the cops than the total profits currently being made by the criminals, but if you enter a legal
amount and click on “Calculate” on the toolbar you will get the results of your entry into law
enforcement. The results will include the price now prevailing in the illegal market, the new
level of profits for criminals, the proportion of the good now being sold on the illegal market,
and the new results for consumer and producer surpluses. (Hint: Look at the sum of consumer
surplus and criminal profits.)
At this point you can go back and choose to try the remaining form of regulation or to disturb the
market. If you choose to impose a price floor, you will go to a screen that allows you to set a
price floor—higher than the current equilibrium price. Once you have entered a valid price you
will see the results of your intervention, including the amounts spent by taxpayers to buy up the
surplus created by the price floor, and to store it for future use (or until it spoils). Again, the
results include the effects of your regulation on the consumer and producer surpluses. (Hint:
When considering the overall effects include consumer surplus, producer surplus, and
government spending—as a negative.)
Mathematical Model
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The basic equations of this module are the supply and demand functions.
Qs = 1*(- 1000+70*(Government Subsidy)+50*(House Price))*(Number of Firms/Lumber Cost)
The numeral 1 is present just after the equals sign to represent parameters you can change when
running the program.
Qd = 833.48 – 10*(House Price) + 30*(Rental Price) – 20*(Furniture Price) + 10*(Income)
If are looking for the market equilibrium, you want the quantity demanded to be equal to the
quantity demanded. Setting Qs equal to Qd and solving the resulting relationship for the price of
house yields (where Ph is the price of a house, F is the number of firms, cost is the price of
lumber, Pr is the rental price, Pf is the furniture price, and Inc is Income):
Ph = (833.48+30*Pr-20*Pf+10*Inc -1*(F / cost)*(-1000 + 700* Government Building Subsidy))
((1 * 50 * (1 – Supply Tax) * (F/ cost)) + (-10 * (1 + Demand Tax)))
If you insert the default values of the various supply and demand variables you should get the
original equilibrium price. If you change any of the variables you can get the equilibrium price
for the new value of that variable (the effect of disturbing the market). Once you have the
equilibrium price, you can substitute the value back into either the supply or demand equation to
get the equilibrium quantity. Even with the equilibrium values you need additional information
to determine the consumer and producer surpluses. You need to go back to the original demand
and supply equations and find the prices at which quantity demanded and quantity supplied hit
zero. With those, you can find the length and height of the two triangles that measure the
surpluses. Of course, if you have changed any of the parameters that will change one of the
numerical values in this result and therefore change the equilibrium price and quantity even with
the original variable values, and the surpluses will be different too. (If the demand and supply
lines were not linear it would be necessary to use integral calculus to determine the two
surpluses, fortunately they are linear.)
To get the effects of a price floor: insert the ceiling price into the demand equation to get the
quantity demanded by the public and into the supply equation to get the quantity supplied. The
difference between these two values is the amount of the surplus generated by the price floor,
and the amount that the government has to buy to keep the price floor intact (avoid having the
price go down due to the law of supply and demand). The amount the government spends is the
amount of the surplus times the price floor. If the price floor is PF:
Government spending = (Qs - Qd)*PF
The amount spent on storage is a constant storage cost per unit times the amount of the surplus.
To get the effects of a price ceiling: insert the ceiling price into the supply equation. This will tell
you the quantity (Qs) that firms are willing to produce at this price. Once the quantity has been
determined the price in the illegal market can be determined. Take the quantity that the firms
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were willing to produce at the legal price (which is all the firms will get) and insert that into the
demand equation and solve for the price of house. The resulting price is the most that consumers
are willing to pay in order to get that number of houses. Since the criminals that buy from the
firms and sell to consumers will charge as much for the house as they can get, while selling it all,
this is the price they will charge consumers. If PI is the illegal price and PC is the ceiling price:
Qs = 1*(- 1000 + 70*(Government Building Subsidy) + 50*(PC)) * (# of Firms/Lumber Cost)
and
PI = [833.48 + (30 * Pc) – (20 * Pb) + (10 * Inc) – 10 * Qs]
The profit made by criminals is the profit they make on each unit (the price they get from
consumers minus what they pay the firms) times the number of units they sell.
Profit = (PI – PC) * Qs
Of course, to get the consumer surplus you need to find the area of the triangle formed by the
demand curve and the line indicating the illegal price. To find the producer surplus you need to
find the area of the triangle formed by the supply line and the legal price.
Hiring cops reduces the number of units the criminals sell (increases the number of units that
consumers get at the legal price). If they are still any selling any units, however, their profits per
unit will increase. To see how this happens, notice that if the police presence causes some house
to be sold to consumers at the legal price this does two things. First, it reduces the quantity
available for the illegal market. Second, it reduces consumer demand by the same amount. If the
amount sold to consumers at the legal price is QL and the amount sold on the illegal market is
QI, while Qs is the amount produced by firms then:
QI = Qs – QL
How much will be sold legally and how much illegally depends on the amount spent on cops
relative to the maximum permitted budget. The maximum is set by the amount of profits the
criminals made before any cops were hired, and if the proportion of house sold illegally is named
“Percent,” the amount spent on cops is “cops,” and amount of prior criminal profit is “crooks,”
the effectiveness is:
Percent = [1 – (cops/crooks)2]
To get the quantity sold illegally, multiply Qs by the value of “Percent.”
The price of house in the illegal market will be:
Pw = (833.48 + (30 * Rental Price) – (30 * Furniture Price) + (10 * Inc) - ((Percent)Qs))/10
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The smaller the quantity sold illegally, the higher the illegal market price and the higher the
profit margin (profit per unit) for the criminals. The overall effect on criminal profits depends on
the relative amounts of increase in per unit profits and reduction in number of units sold illegally.
In the portion of the demand curve where demand is inelastic, the price increase will be large
compared to the decline in quantity and profits for criminals will increase. In portions of the
demand curve where demand is elastic criminal profits will decline. You should recall that in a
straight-line demand curve the price elasticity of demand varies along the curve.
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